Raising Estimates As Starbucks Brews Up Stronger Growth

by Trefis Team
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Starbucks Corporation (NASDAQ:SBUX), the world’s largest coffee chain, announced a very strong set of results recently as the company’s profits jumped 25% to $418 million. Starbucks also raised its earnings guidance and now expects net income of $2.22-2.23 per share in fiscal 2013, up from its previous estimate of $2.12-2.18 a share. Shares of the company soared 7% after the earnings beat.

Following the earnings, we have raised our price estimate for Starbucks to $67, which is about 10% below the current market price. Here are the reasons why:

See our full analysis for Starbucks

Rising Margins

Starbucks’ margins are benefiting from low coffee prices. The company’s most important raw material, namely Arabica coffee, is trading near a three-year low and prices aren’t expected to rebound anytime soon. Grim demand for Arabica in Europe is pushing down the prices. As long as the macro-economic conditions remain grim in Europe, Arabica prices will remain subdued.

In the latest quarter, Starbucks’ operating margins rose 150 basis points to 16.4%. We expect the margins to show some further improvement as the company leverages its sales growth.

Growing Traffic

Starbucks blew away expectations by announcing a massive 9% rise in the same-store sales, helped by 8% surge in the customer traffic. Starbucks is a mature company with more than 17,000 stores globally so growing traffic by 8% came as a huge surprise for the market.

Starbucks did not reveal the breakdown of these results, but it is clear that the company’s footfalls are getting a boost primarily due to the rising number of customers using smartphone technology to order and the expanded food menu.

More Americans are using smartphone technology to make purchases at their favorite restaurant chains. Ten percent of Starbucks’ payments were made through smartphones in the previous quarter. Paying through mobile phones allows customers to skip queues, the effect of which was evident on the traffic volume. Last year, Starbucks poured in $25 million in a payment start up called Square, and is playing the technology game pretty well.

Additionally, the expanded food menu is also attracting more traffic. Starbucks acquired the San Francisco based bakery chain La Boulange last year for $100 million. The company is now offering more food products at its Starbucks stores and hopes to increase the proportion of food orders. Till last year, only one-third of the billings comprised of any food product.

By the end of the third quarter, La Boulange products were available in 1,076 of its company-operated stores across the U.S. By the end of 2013, the extended menu will be available in about 3,500 of the company-operated stores in the U.S.

This quarter was exceptional though it would be overly optimistic to assume that these growth rates could continue. We expect same-store sales to slow though it shouldn’t fall below 4-5% annually.

Same-store sales, or comparable sales, is an important parameter to gauge a restaurant chain’s performance since it excludes the effect of currency fluctuations and only includes the restaurants open for more than a year. The sales of newly opened restaurants could be unusually high or low and can distort the overall revenue/store figure.

Teavana Stores

We have aggressively increased the revenues from its Seattle’s Best and Other division since this now also includes the revenues from Teavana stores as well. Teavana is an Atlanta based tea company acquired by Starbucks last year for $620 million. Teavana operates nearly 350 stores and is expected to provide significant top line growth for the company in the years to come.

Although there lies a huge opportunity for Starbucks to open Teavana stores across the country, we have generally kept the growth rates a bit conservative since there has been no official announcement from Starbucks on this regard.

Packaged Product Sales March On

Starbucks’ channel development (CPG) segment consists of packaged coffees and teas such as VIA Ready Brew, K-cups and brewers available in grocery and retail stores. With revenues of this segment totaling $1.3 billion in 2012, the division has begun to make a mark on the company’s income statement.

During the earnings release, Starbucks announced a partnership with the French giant Danone, which will see the company launching new specialty yogurt products (such as Greek yogurt) beginning from next year. In its second quarter earnings, the company announced the extension of its deal with Green Mountain as well.

Starbucks has an ambitious plan of doubling its international footprint for this segment within the next two to three years. While the growth of this division moderated to 8.8% in the quarter, it is still up 11.8% in the first three quarters of the fiscal combined. This division should continue to witness impressive growth as the company keeps expanding into new geographies and introduces new products.

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